By Rob St George of Citywire

With rising inflationary pressures and pension fund woes, UK retailers are pinning their hopes on a bumper festive season. Analysts give their verdict on what to expect this Christmas

Embattled and retrenching, their pension deficits ballooning, there is little festive cheer among the UK’s retailers.

Marks & Spencer, for example, announced that it expected to reduce its number of full-line stores – those selling food, clothes, and home wares – by around 60 over the next five years, while confirming that for the half-year to 1 October 2016 its statutory profit before tax had plunged by 88%.

It was not alone among UK retailers in releasing poor numbers this reporting season. Underlying profit before tax at Sainsbury’s fell by 10% in the half-year to 24 September 2016. Sales at Next during the quarter to 31 October 2016 slipped by 3.5%, and the store narrowed its sales guidance for the full year to between -1.75% and +1.25%, from -2.5% to +2.5%.

Following the collapse of BHS earlier this year, many industry watchers will also have been perturbed by the worsening finances of many retailers’ pension plans.

Tesco revealed in October that its net pension deficit had surged from £3.2 billion in February to £5.9 billion now. The black hole in Sainsbury’s pension scheme is almost £1.1 billion.

Tall retail

Yet despite these high-profile woes, the UK retail industry in aggregate is performing better than may be expected.

According to the latest British Retail Consortium/KPMG Retail Sales Monitor, UK retail sales increased by 1.7% on a like-for-like basis from October 2015 and by 2.4% on a total sales basis. This represented the strongest growth since January, and was well ahead of the three-month and 12-month averages of 1.1% each.

Helen Dickinson, chief executive of the British Retail Consortium, took particular comfort from the fact that this growth was recorded across all product categories, rather than being skewed by just one sector.

‘Notably, fashion saw a reversal of recent fortunes, as new seasonal ranges drew shoppers in and boosted sales,’ Dickinson observed. ‘Electronics too saw a strong sales resulting from new product releases and was a significant driver of the month’s performance. This was compounded by international shoppers’ spending, which has soared since July as tourists take advantage of the weak pound to buy luxury goods at bargain prices.’

Dickinson added that ‘despite the inflationary pressure that’s gradually building in the supply chain, retailers are currently effectively managing the additional cost burdens and continue to entice their customers with great choice and value’.

Paul Martin, UK head of retail at KPMG, was also encouraged by the contribution to October’s performance from a wide range of retail segments, including children’s clothing and jewellery. ‘With retailers already a third of the way through the golden quarter, and Black Friday weekend and Christmas looming, they will be hoping to maintain momentum by capturing the attention of shoppers in the noisiest time of year,’ Martin commented.

Others were more cautious, however. ‘A major concern for the economy – and retailers in particular – is that it looks inevitable that the fundamentals for consumers will progressively weaken over the coming months with inflation rising markedly due to the weakened pound and companies likely increasingly looking to hold down pay to limit their total costs,’ argued Howard Archer, chief European and UK economist at IHS Markit.

Inflation deflates expectations

This new inflationary environment will indeed be a challenge for retailers. The National Institute for Economic and Social Research
Consumer has predicted that inflation will continue to accelerate and peak at around 4% in the second half of 2017, warning that ‘this will impact on real disposable income’.

On the one hand, retailers tend to benefit from mild inflation as it enables them to increase prices. But if inflation is too high – and 4% is twice the Bank of England’s target – retailers suffer from the double hit of employees demanding higher wages and consumers deterred from spending by high prices.

Navigating all this will place huge demands on management teams at retailers. Not all will be up to the task, but for investors in the best retailers the rewards should be significant.

This article is independently written by Citywire and not subject to editorial oversight by Blackrock